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Written by: Kyle Jahnke, CFP® | Retirement & Wealth Strategies
Retirement is generally viewed as an ending. The end of waking up early to commute to work. The end of stressful deadlines. In reality, many retirees are disappointed to find that the worries that they left at the office have been replaced by new fears. How will I spend my time? How much of my savings can I spend without running out of money?
If not prepared, these unknowns can seriously dampen what could otherwise be one of the most exciting times of life. Part of being prepared is being educated. In the article below, we will dive into three time-tested approaches to retirement income to learn more about which strategy could be right for you.
Strategy 1: The Income-Only Approach
A timeless classic and favorite of conservative investors, the income-only (or interest-only) method funds retirement spending primarily from the cash flow generated by investments, without touching principal.
Investors using this approach focus on owning securities that pay regular income, such as dividend-paying stocks, bonds, and CDs. These payments, often referred to as “yield,” form the basis of their retirement paycheck.
Pros
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Reduced Market Dependence: Because withdrawals come from dividends and interest rather than selling shares, retirees often feel more insulated from market swings, as it is less likely that they would need to sell investments at a loss.
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Spending Comfort: For many retirees, the idea of running out of money tops the list of things to worry about in retirement. While no investment strategy is without risk, the concept of living off a portfolio’s income can provide comfort to risk-averse investors.
Cons
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Limited Investment Options: Not all investments generate meaningful income. By focusing on yield, portfolios may become concentrated in certain sectors and underexposed to growth-oriented equities, which have historically driven higher long-term returns.
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Income Volatility: While yield from investments doesn’t change overnight, it is important to remember that dividends and interest payments aren’t guaranteed. Interest rates fluctuate, and companies can reduce or suspend dividends. When targeting a specific yield, investors do need to actively monitor their portfolio for changes.
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Spending-averse Mindset: While the income-only approach creates helpful guardrails for spending, it can unintentionally lead investors to feel that they can never spend principal. In reality, many comprehensive retirement plans involve the controlled spending down of a portfolio over time as it fits the client’s goals.
Strategy 2: The Bucket Approach
Also known as the time-segmented approach, this strategy divides a retirement portfolio into multiple “buckets,” each serving a different purpose and time horizon. A common setup might look like this:
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Bucket 1 - Short Term (1-3 years): Cash, short-term bonds, and CDs to fund near-term spending.
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Bucket 2 - Intermediate Term (4-10 years): A mix of intermediate bonds and balanced equities to replenish the short-term bucket.
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Bucket 3 - Long Term (10+ years): Primarily equities aimed at outpacing inflation and supporting future withdrawals over the long haul.
Pros
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Goal-Based: While the total mix of stocks, bonds, and cash may resemble a traditional balanced portfolio, the bucket approach assigns each portion a clear purpose tied to time-based spending goals. By clearly assigning a goal to the various pieces of a well-balanced portfolio, investors often feel more reassured knowing that each investment segment was built to help them achieve real, tangible goals as opposed to simply chasing returns.
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Sequence of Returns Protection: Buy low. Sell high. One of the basic rules of investing, right? The reality is that when retirees begin taking monthly withdrawals from their investments, there will most likely be cases when they are forced to sell investments at a loss to fund their spending. By taking withdrawals from a bucket invested in stable, liquid investments, the more aggressive pieces of a portfolio, such as growth equities, can be left to benefit from a potential recovery without the need to be sold.
Cons
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Complex Implementation: When implementing, it can be challenging to know exactly how much to allocate to each bucket without careful income planning. Executing can become more complex when trying to manage the buckets between spouses and account types, as different registrations and tax categories can make shifting funds difficult.
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Ongoing Maintenance: Once set up, the buckets will each require ongoing maintenance to stay within the original targets. Having structured rules guiding when and how to rebalance and refill buckets is key.
Strategy 3: The Total Return Approach
The total return approach aims to fund retirement by replenishing distributions using the total return of the portfolio. Instead of only using income produced by investments, all sources of return play a role, including interest, dividends, and price appreciation of the investments themselves.
This strategy often mirrors the way many investors manage their portfolios during their working years, focusing on diversification, risk management, and total growth without overcomplicating the process.
Pros
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Broad Diversification: Without yield or cash constraints, investors can build a highly diversified mix of investments that are intended for growth, given their risk tolerance. This focus on diversification can lead to improved risk reduction over long periods.
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Simple Implementation: As noted above, most investors will be comfortable with this style of investing, as most have invested similarly throughout their careers. Focusing on asset allocation rather than separate income or bucket targets simplifies management across multiple accounts and can easily be automated through periodic rebalancing.
Cons
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Sequence of Returns Risk: Without a dedicated cash reserve, retirees may be forced to sell investments during market downturns to meet withdrawal needs, which can significantly impact the long-term success probability of a retirement plan.
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Behavioral Challenges: Some retirees are uncomfortable with the perceived lack of structure in the total return approach. Without a yield to achieve or earmarked buckets for spending, fear of either over-spending or under-spending can creep in. Having a robust retirement plan that is revisited often can work wonders to help relieve some of these fears and provide the guardrails that investors seek.
Choosing a Strategy
There’s no one-size-fits-all retirement income strategy. An investor with longevity in their family and a frugal mindset may gravitate towards the income-only approach. Someone with specific goals and an intricate plan may resonate with the bucket strategy. For many, the simplicity and familiarity of the total return approach make it an obvious choice.
The bottom line is that the right strategy is the one that allows you to stay invested and confident as you make the leap to retirement. Speak with a professional. Map out how the different strategies would look in your own life. If you’ve done your homework, I’m willing to bet that one plan will resonate.
Related: How To Plan for 2025 Year-End Mutual Fund Capital Gain Distributions